Today we are going to look at Chesapeake Utilities Corporation (NYSE:CPK) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Chesapeake Utilities:
0.083 = US$98m ÷ (US$1.7b - US$509m) (Based on the trailing twelve months to March 2019.)
Therefore, Chesapeake Utilities has an ROCE of 8.3%.
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Does Chesapeake Utilities Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Chesapeake Utilities's ROCE appears to be substantially greater than the 5.9% average in the Gas Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from how Chesapeake Utilities stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Chesapeake Utilities.
Chesapeake Utilities's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Chesapeake Utilities has total liabilities of US$509m and total assets of US$1.7b. As a result, its current liabilities are equal to approximately 30% of its total assets. Chesapeake Utilities's middling level of current liabilities have the effect of boosting its ROCE a bit.
Our Take On Chesapeake Utilities's ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.